The non performing assets have reached sky scraping heights in recent times in India. This led to serious thinking and ultimately the government proposed changing laws to deal with the problem. Has the journey for an effective insolvency system for bringing financial system stability reached its end? Find out more in the story
India is growing fast. It is one of the fastest growing economies of the world. However, if this growth is to be sustained, Indian banks and India’s insolvency and bankruptcy regime have to reinvent themselves in terms of their key promises and functions. Indian Banks have been at the receiving end of the system which allows piling of non-performing assets. The banks in India have $121 billion troubled debt pile, over $100 billion of which is on the books of public sector banks. According to RBI data, stressed assets rose to 14.5% of the banking sector loans at the end of December 2015. The banks have written off more than ` 1,14,000cr of bad loans. The Supreme Court of India has asked the government to overhaul the banking system to prevent bad loans. Companies have floundered public money and there is no effective legal and institutional mechanism to recover them from the defaulting entities.
The banking sector reflects the economic health of the country. The strength of economy of any country hinges on the strength and efficiency of the financial system, which in turn depends on a sound and solvent banking system. While credit growth is one of the drivers of economic growth, NPAs are value destroyers of the economy. As per RBI norms, any interest or loan repayments delayed beyond 90 days has to be identified as NPAs.
A large number of defaulters strategically defaulted on their repayment obligations on realizing that the legal machinery was ineffective in taking up steps against them. As per the RBI guidelines, a wilful defaulter is one who defaults in meeting its obligations to the lender when it has capacity to honour the obligations or when funds have been utilized for purposes other than those for which finance was granted. As per the reports, lenders in India are able to recover only 20% of their loans when businesses go bankrupt as against 70% recovery rate in developed countries.
To curtail this menace of rising NPAs, and poor recovery of loans, reforms of all sorts – banking, financial, corporate – were important. However, what was most urgent was a massive reform in the insolvency and bankruptcy laws in India. According to experts, a well functioning insolvency laws is fundamental to the development and growth of robust credit markets. So, the government of India, after the matter reached alarming proportion, acted accordingly, and an effort at comprehensive reform was undertaken when the Ministry of Finance in India set up the Bankruptcy Law Reforms Committee (BLRC) in 2014 under the Chairmanship of Mr. T.K. Vishwanathan (former Secretary General, Lok Sabha and former Union Law Secretary). The mandate of the Committee was to recommend an Indian Bankruptcy Code, applicable to all non-financial corporations and individuals that would replace the existing framework. The committee submitted its report and the draft Insolvency and Bankruptcy Code to the government in November 2015.
At present, Indian laws do not facilitate speedy and effective enforcement mechanism to mange NPAs. because there is no single, comprehensive law that addresses all aspects of insolvency and bankruptcy. The Indian insolvency legal system is fragmented and fraught with delays in enforcement. The time taken to resolve corporate insolvencies and the banker’s recovery rates have been extremely poor as compared to developed countries. According to latest report by World Bank, out of 189 countries, India currently ranks 136 in the World Bank’s resolving insolvency ranking and it takes 4.3 years to resolve insolvency in India. In the UK it takes one year and in the US it takes one a half years.
Insolvency is a situation when an individual or a firm is unable to meet the financial obligations due to its creditors. Bankruptcy, on the other hand, is a legally declared status that an individual or a firm cannot repay debts. So, an individual or a firm becomes insolvent when it cannot meet its financial obligations to repay its debts where as bankruptcy is a determination of insolvency made by a court of law with resulting legal orders intended to resolve the insolvency. Insolvency is a situation where a debtor, be it individual or a corporate, is unable to meet their obligations.
However, the issue in insolvency or bankruptcy is not just securing the loans back from the defaulter and winding up the businesses. Before going for liquidation, it is to be first seen if it is possible to restructure the company to make it work for the larger interest. So, corporate bankruptcy is an issue which goes beyond securing loans back; it has social as well as commercial context. Many business houses which are in the defaulting list employ thousands of persons and their lives will be affected too by the decision that the authority or the court takes. So, the law of insolvency is a social legislation to provide respite and relief to the honest debtors who due to any unfortunate or unforeseen circumstances become incapable of paying back their debts.
Recently, Raghuram Rajan, RBI Governor, speaking at Columbia School, New York, said that the issue of bad loans gets loaded with a lot of morality and it is necessary to keep criminal liability separate for putting the stressed assets back on track. He said, “What is happening on the NPA front… this becomes loaded with a lot of morality, are these good people, bad people. I think one should take out morality from the NPA clean up.” So, the law should provide a reasonable opportunity for rehabilitation of a business before a decision is taken to liquidate it so that it can be restored to productivity and become competitive.
So, an effective insolvency system is an important element of financial system stability. According to a Committee appointed by Ministry of Corporate Affairs, “the framework of insolvency and bankruptcy law should seek to preserve estate and maximize the value of assets; recognize inter se rights of creditors and provide equal treatment of similar creditors while dealing with small creditors equitably. It should enable a timely and efficient resolution of insolvency and establish a framework for cross border insolvency. The present framework does not provide a balanced resolution of various stakeholder issues, is time consuming and inefficient.”
So, there is no single law that deals with insolvency and bankruptcy in India. The legal redressal is time consuming. Different agencies like the High Courts, The Company Law Board and The Board for Industrial and Financial Reconstruction [BIFR], and the Debt Recovery Tribunals [DRTs], have overlapping jurisdiction, giving rise of systemic delays and complexities. In principle, the Companies Act, 1956 contains the main legal provisions for dealing with corporate insolvency. The current system is focused on the recovery rights of banks as secured creditors and largely ignores the interests of unsecured creditors (such as bondholders), domestic institutional creditors other than banks (such as nonbanking financial companies or NBFCs) and foreign creditors.
The Presidency Towns Insolvency Act, 1909 and The Provincial Insolvency act, 1920 are applicable only to individuals, sole proprietorships and partnership firms.
India has taken a giant leap in adopting a new bankruptcy law after the Lok Sabha passed the bill Insolvency and Bankruptcy Code, 2016. The bill is aimed at expeditious resolution of insolvency, promotion of fruitful investments, releasing resources of the banking sector locked up in unproductive segments, improving the viability of the credit markets and generally easing the business controls in India.
In the words of Jayant Sinha, Minister of State for Finance, “Insolvency and Bankruptcy Code Bill is transformational building block for the economy and there would be one law dealing with bankruptcy while doing away with at least 12 different legislations, some of which are centuries old. This will also make the whole process more transparent.”
The Bill amends the Companies Act, among many other pieces of legislations, to become the overarching legislation to deal with corporate insolvency.
The Code creates time-bound processes for insolvency resolution of companies and individuals. It sets up a time limit of 180 days during which corporate insolvency will have to be resolved. However, if within 180 days, 75% of creditors do not agree on the revival plan, the firm automatically will go into liquidation. If the three-fourths of the creditors decide that the case is complex and may not be addressed within 180 days, an extension of 90 days can be provided.
The resolution processes will be conducted by licensed insolvency professionals (IPs). These IPs will be members of insolvency professional agencies (IPAs). IPAs will also furnish performance bonds equal to the assets of a company under insolvency resolution.
Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.
The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies. The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs. The Code also sets up a fund called the Insolvency and Bankruptcy Fund of India.
As for the distribution of proceeds after the liquidation, firstly, insolvency resolution process cost and liquidation costs are to be paid in full. It will be followed by the debts owed to Secured Creditors, then the workmen’s dues for 12 months, followed by unpaid dues to employees other than workmen, and financial dues owed to Unsecured Creditors. Government taxes for two years, other debts, preference shareholders and equity shareholders will receive last priority for payment. Importantly, the Code also provides for monetary penalty and jail term of up to five years for concealment of property, defrauding creditors and furnishing false information.
The new, proposed legislation is a step in the right direction. It is timely and has many positive aspects which will go a long way in stopping the accumulation of bad debt, help free our system of scourge of defaults occurring at the current pace and a timely resolution of insolvency and bankruptcy in India. For the first time, restructuring will be available to a non industrial company. With the new legislation, it will be possible for the company to go for early solvency resolution process. The strict time line is another major step in the right direction. The Code gives rise to the introduction of insolvency professionals who will conduct the insolvency resolution process, take over the management of a company, assist in collection of relevant information and manage the liquidation process.
However, the experts have raised concerns as to the role of the government which will be more direct after this bill gets passed in the Upper House and finally gets its ascension by the President. They point out that the government has to stay outside and supervise the whole process. The constitution of Insolvency and Bankruptcy Board which will have the power to appoint, license insolvency professionals and hold disciplinary proceedings against them is fraught with unwanted consequences. They recommend doing away with the board altogether and letting the new breed of solvency professionals self regulate themselves. Another objection is regarding the vesting jurisdiction with DRT for personal insolvency. Experts have pointed out that it will make law inaccessible. DRT at present has huge backlog of cases and many tribunals are not functioning at present.
As for National Company Law Tribunal, which will handle cases of corporate insolvency, it has still not been constituted. So, there is a need to constitute without any delay not just the NCLT but also other new institutions proposed to be constituted in the Code. So, clearly, the implementation will now be the key factor going forward. But, the Code on the whole is a timely legislation that will expedite resolution of insolvency and make the process of debt recovery easy for creditors.
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